Ismail is a successful mule trader in Peshawar. Every year Ismail
delivers 30 mules to the Kabul Mule Market and gets $40 per mule.
This year, however, the Khyber Pass is full of warlord militias, so Ismail
is not sure he can drive his mules to market without losing a mule here
and there. Also, the demand for mules in Kabul seems to be dropping.
Maybe he'll only be able to sell 20 mules, or, God forbid, 15, and then be
forced to feed and water the rest of them on a money-losing trek back
home. In other words, it's a scary market and Ismail is worried
about feeding his family.

What Ismail needs is to limit his risk with an Enron
derivatives package. First he pays $2 per mule for a Khyber Pass
Derivative, so that any mule killed or stolen by warlords will be
reimbursed at the rate of $20 per mule - half the going market rate, but
still better than taking a total loss. Next he buys Enron Mule Futures.
For $28 per contract, he guarantees delivery of a mule in three months
time. He takes 15 of these, figuring that a guaranteed $28 mule sale is
better than showing up in Kabul and discovering that the mule buyers have
been killed by stray bombs.

Meanwhile, at the Enron Mule Trading Desk in Houston,
eagle-eyed yuppies are studying the worldwide mule markets and are
starting to have their doubts about those $28 delivery contracts. Mule use
is dropping all over Afghanistan, even as the mule count is dwindling.
Better resell eight of those 15 contracts to a European commodities broker
for $24 each, then make up that $32 loss somewhere else while cutting the
company's exposure in half. But how to hedge the risk on the other seven?

Ah ha! A blip on the computer screen. A
temporary mule shortage in southern Iran! With a current mule price of $42
in Tehran, Enron could offer a Linked Mule Swap Double Derivative tied to
the gap between the price of mules delivered in Kabul on a given date and
the price in Tehran on the same date. Sure, you would rather have the
quick-and-clean Iran sale, instead of the sale in Kabul that requires
trucking the mules to a foreign market. But even if you add in $4 per mule
for transport through militia-held territory and averaged the markets
together, you can still clear eight bucks just on the gap alone.

Enron's average price-per-future-mule is now $32.57
when you include the $4-per-mule loss on the mule futures dumped in
Europe. But based on the amazing $12 Kabul/Tehran trading gap, they can
easily put together a "delivery in either market" contract that will allow
them to ask $36 per mule on their Mule Online Internet trading system. The
first mule future sell instantly for $36, and the price bobs up to $36.50.
Two mules go for $36.75, and then there's a big jump for the last three
mules to $37.90. Enron has now off-loaded all its price-based mule futures
liability for a profit of $31.70.

But this doesn't mean they're out of the mule market
in Central Asia. It's still two months until Ismail delivers his 30 mules,
and Enron is on the hook for his Khyber Pass derivative insurance policy.

Things are not looking good in that part of the
world, either. The chances of a mule being picked off as a road-passage
tax are pretty high, and the loss of the whole herd would be a $600
liability. Quickly, the financial boys go to work, and part of that
liability is resold to a consortium of Singapore banks, Australian mutual
funds, and Saudi Arabian arms merchant Adnan Kashoggi, thereby reducing
Enron's percentage to 25 percent, or $150 in potential liability against a
$15 premium (remember the $2 per mule paid by Ismail), and Enron also
takes a brokerage fee of $20 from the three other partners, thereby
reducing its real liability to just $120.

But that's still too much of a spread, so Enron
continues to hedge. Fortunately, the company has such a diversified
trading floor that Enron mule-market experts can walk over to the traders
in the warlord-militia derivatives department. Sure enough, at least four
tribes near the Khyber Pass are increasingly concerned about profit
margins. There simply aren't enough people to rob. Things have gotten so
bad, in fact, that the warlords are hedging against the oncoming winter by
taking futures positions in stolen chickens, stolen humanitarian aid
trucks, and Western hostages. There's not a mule market yet, because the
warlords have successfully converted many of the recalcitrant villagers
into pack animals. But Enron knows how to MAKE markets.

Quickly the numbers-crunchers go to work, and they
soon determine that the average number of stolen mules per 100-man militia
is 1.4 per year. That represents anywhere from $28 to $56 in lost
mule-thievery income if the Khyber Pass is closed or inhospitable to
traders from Pakistan. Amortizing that amount over 12 months, the warlords
have an exposure of anywhere from $2.33 to $4.67 per month in lost
pillage. Hence, Enron announces the new Highway Robbery Derivative, in
which each tribe is guaranteed the value of two stolen mules in each
12-month period in return for paying a premium of $4 per month.

Enron's hedge is now complete, and it's a beautiful
thing to behold. The chances of Ismail losing a mule to a raiding party
are approximately one in 30, or 3.33 percent. Since he's paying $60
for his derivative contract, the expected loss of 3.33 percent of his herd
would result in a payment of only $20, which is a more than comfortable
spread. Meanwhile, if the mule is stolen by a warlord holding a Highway
Robbery Derivative, then the payment to the other side would only be $28
against premiums of $48. If Ismail simply passes through the Khyber
Pass without incident and sells all his mules at the standard price, Enron
pockets $60 from Ismail and $48 each from four warlords, in addition to
the previous profit of $31.70 from that heady Internet mule-futures
trading day and the $20 in packaging commissions. If each warlord
steals his standard 1.4 mules per year, then Enron still owes six-tenths
of one mule to the warlord, or about $22.20 based on a $37 sale price.

Total expected profit, based on 5.6 stolen mules, one
of which is stolen from Ismail: $143.20.
Total profit from all Ismail-related mule transactions: $194.90.

See, it's simple when you know how it works.
Just ask Arthur Andersen.